If you have a long-term investment horizon of at least ten years, your best investment may not be mutual funds, ETFs, growth stocks, bonds, or gold. Instead, consider investing in a diversified portfolio of high-quality, dividend-paying stocks. Follow these steps to build a portfolio that will achieve high long-term returns and provide dependable dividend income.
Learn how dividend stocks produce yields. A stock’s return consists of both share-price growth and dividend yield. For example, a company that pays a 5% dividend yield in a given year and appreciates in share price by 5% that same year, provides an annualized 10% pre-tax return to stockholders. High quality (dependable growth) is necessary to ensure that the dividend payout will be consistent (or even increase) year after year.
- Companies pay dividends because their estimate of return by keeping the money internally is not high. This means that those companies that pay dividends do so because they are not reinvesting profits in order to grow.
- However, growth companies are more interested in reinvesting their capital in order to grow their operations and (hopefully) their share value, so these companies do not pay dividends.
Compile a list of candidate stocks. There are thousandsof stocks on the market, but not all are suitable for dividend investors. There are several ways to narrow your search for top-quality dividend stocks:
- Research the 30 stocks from the Dow Jones Industrial Average (DJIA). These are large American companies that are leaders in their respective industries. Many of them have the high-quality characteristics required for long-term performance, but some may not. This list is important, because it is a widely used benchmark for the U.S. stock market. Evaluate each company on the list in light of the criteria discussed in later steps.
- Use an online stock screener such as eSignal to screen for stocks with a market cap of at least 100 million dollars and a dividend yield of at least 150% of the Standard & Poor’s 500 average yield. (If the S&P 500 averages a 2% dividend yield, look for stocks with at least a 3% dividend yield). Search also for stocks with a five-year average return-on-equity of at least 15%, a long-term debt-to-equity ratio of less than 1, interest coverage of at least 5% (see note in the Warnings section), and a 10-year earnings-per-share (EPS) growth of 5% or more. This should narrow down the list of candidate stocks considerably. In fact, most stocks found by an online stock screener will fail to satisfy this list of criteria in full and thus will not qualify as high-quality dividend stocks. Additional research is necessary, as outlined in later steps.
- Look at the list of holdings of mutual funds that invest primarily in high-quality dividend stocks, such as (among many others) the Vanguard Dividend Appreciation Fund.  Such a list contains good suggestions for finding high-quality dividend stocks.
- Find a list of dividend achievers, those stocks with a history of raising dividends over time. Look for such a list in the financial press, on financial websites, or from certified financial advisors.
- Look at the list of dividend aristocrats: stocks that have consistently increased dividends every year for at least 25 years. You can find the most updated list by doing an internet search. This list of blue chip stocks consists of top-quality dividend stocks that meet the criteria mentioned here.